Here Are 4 Things We Learned About Investing In 2013

In 2013, interest rates rose, bonds fell, equities soared, and US income-tax rates climbed higher. Before starting to place bets for 2014, investors would be wise to think about some important lessons from 2013.

1. You Have to Be in It to Win It

The stock market has surged since 2009, but for most of this time, investors were busy taking money out of stocks and hoarding cash and bonds. According to Lipper and Strategic Insight data, individual investors withdrew nearly $320 billion from US-domiciled stock portfolios between 2008 and 2012, with no let up as it nearly doubled from the bottom reached in early 2009. But during 2013, investors began to pile back in: positive flows into US-domiciled stock portfolios were a whopping $182 billion through November 2013 (Display).

AllianceBernstein Blog

Staying on the sidelines may seem safe, but it also ensures a loss of purchasing power over time. Although equities are no longer the bargains they were at the market bottom in 2009, we think that they remain attractively valued, especially in comparison with bonds. Investors need to maintain an appropriate allocation to return-seeking investments such as stocks to reach their financial goals.

2. If You Run with the Crowd, You Can Get Trampled

After the credit crisis, investors favored high-dividend-paying stocks such as utilities, consumer staples and telecoms over other stocks, because of their bond-like qualities: solid income and perceived stability. Because of this crowding, the prices of these “safe” stocks climbed well beyond what we would consider to be their fair value, ultimately reaching a 50% premium to their normal valuation. For example, in the 12 months ending April 2013, the S&P 500 telecom sector was up 28.8%, versus 16.9% for the S&P 500 as a whole (Display).

AllianceBernstein Blog

But in the spring of 2013, as Treasury bonds dropped in value, these bond-like stocks moved down, too. From May to November, these “safe” investments were anything but: Utilities fell 6.3% while the overall stock market gained 14.5%. High-dividend-paying stocks remain somewhat expensive, and we think that they have further to fall—if not in absolute terms, then relative to the broad market.

Something similar happened to gold, another crowded trade in the post-credit-crisis years. Investors bought gold because they expected it to be a long-term store of value and a hedge against inflation. In 2013, the shiny metal lost some of its luster. The gold price—$1,694 an ounce at the start of January—slid 26%, to $1,253 an ounce at the end of November.

Following the crowd usually means chasing past returns. That’s no more sensible than looking in the rearview mirror to steer your car. A more effective (and safer) approach is to establish your own investment strategy based on your circumstances, risk tolerance and market fundamentals, and to stick to it no matter what the crowd does. That will sometimes make you a contrarian…until the crowd joins you.

3. Diversification Means Owning Some Things That Underperform

To illustrate this point, let’s look at equity returns by geography. Of the three broad stock-market segments—US, international developed and emerging markets—the top performer in 2012 was emerging markets, and the bottom performer was the US. This year, those rankings were reversed: US equities returned a stunning 29.1% through the end of November, as measured by the S&P 500; developed international stocks (represented by the MSCI EAFE Index) returned a healthy 21.0% in US-dollar terms; but the MSCI Emerging Markets index returned negative 1.2%.

Next year, either developed international stocks or emerging-market stocks could end up on top. The real lesson here is that you can’t predict what’s going to do well in the future, so owning a laggard at any moment in time is critical to diversification.

To capture the strongest returns no matter where they may appear, investors need to maintain exposure to stocks in all the key regions. For us, 2013 shows that diversification still matters a lot.

4. It’s What You Keep That Counts

Taxes for high-income individuals went up across the board in 2013. Between the American Taxpayer Relief Act (ATRA) and the new Medicare surtax, some will face a 2013 tax bill that’s more than 14% larger than last year’s. All taxpayers—but these in particular—stand to benefit from tax-management strategies.

There are several good ways to defer taxes, such as harvesting tax losses, contributing to retirement plans and delaying the recognition of income. There are also a smaller number of ways to avoid present or future taxes altogether, such as making a charitable donation or contributing to a 529 Plan.

Investors who adopt tax-aware approaches can improve their financial situation, whether through deferring taxes or permanently avoiding them. Although time is short, this lesson is best applied now, rather than in April. Especially if you’re subject to the new, higher rates, tax management should be an integral part of your investment strategy.